Some Intense Short Covering Could Be Around The Corner

February Crude Oil

The week started out strong with February Crude Oil futures spiking to $38.39 early during Monday's session, but by the end of the day, the market was trading over 1% lower.

Prices jumped early in the session on new tension between Saudi Arabia and Iran. This was in reaction to events over the long holiday week-end where Saudi Arabia cut diplomatic ties with Iran after Ayatollah Ali Khamenei said Saudi Arabia would face "divine revenge" for executing a top Shite cleric, Sheikh Nimr, along with 46 others, many of whom were members of al-Qaida.

According to Reuters, Saudi Arabia said it will end all commercial ties with Iran in response to an attack on the Saudi Embassy in Tehran. Bahrain said it would also cut ties with Iran.

This news triggered a rally initially because traders thought it would lead to interruptions in supply especially since Iran is getting ready to boost production by up to 1 million barrels a day as sanctions imposed by the West on Iran could be lifted as early as this month.

Prices began to weaken, however, as traders saw no immediate threat to supply from the Middle East. In fact, the thought that the conflict between the two nations would lead to higher prices backfired as traders shifted their thoughts from bullish to bearish. By the end of the week, more investors were leaning on the short side of the market because a lingering conflict would lessen the chance that Iran and Saudi Arabia would agree on production cuts in the future.

Also topping the Mideast tension news were worries about an economic slowdown in China and fresh stock market turmoil, which caused similar reactions to the financial markets like they did in late August 2015.

According to a report, Chinese manufacturing activity fell for a 10th straight month. Manufacturing activity in another major oil consumer, India, fell for the first time in two years.

By mid-week, the rout was on as traders responded to a large build-up of U.S. gasoline supplies and a report that North Korea had successfully tested an H-Bomb.

February Crude Oil prices are likely to finish the week near a 12-year low after falling sharply on Thursday to nearly $32.00 a barrel. Although most investors are concerned about the world glut in crude oil, there was some speculative buying near the end of the session, which suggests the market may be technically oversold. Traders could also be betting that the fears over an economic slowdown in China may be overblown and that U.S. stockpiles may have reached a peak. 

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Technically, the main trend is still down on the weekly chart. The market isn't even close to turning the main trend to up according to the swing chart, however, it is ripe for a closing price reversal bottom. This occurs when the market makes a lower-low than the previous week, but closes higher for the week. This type of chart pattern doesn't mean the trend is turning, but it is a strong indication that the buying is greater than the selling at current price levels. Short-sellers should be aware of this pattern because it could lead to a serious short-covering rally, which means you're going to be giving back profits if you haven't adjusted your trailing stops.

The Gann angle analysis shows that the market encountered a wall of resistance slightly under the previous main bottom at $40.69. This week, the angle that stopped the market the last four weeks drops down to $38.19.

The next downtrending resistance angle drops in at $35.69. Overtaking this angle will indicate the presence of buyers.

Based on this week's steep sell-off, the first downside target is another downtrending angle at $30.69. Although buying a falling market is not recommended for new long traders, this price could become support if short-sellers decide to book profits. If a closing price reversal bottom is going to form next week, it is likely to do so following a test of the angle at $30.69.

The angle at $30.69 is important next week because if it doesn't hold, the market could go into a free fall based on the weekly chart. The next downside target is a downtrending angle at $20.69.

Watch the price action and read the order flow at $30.69 all week. The market may straddle this price most of the week until traders decide what they want to do. Testing this level then closing above the previous week's close will be a sign of a short-term bottom. While a close under this level will indicate an exhaustion break may be coming.

Remember that the last time China was in trouble, it came in with massive stimulus around August 24. This helped put the bottom in at $40.69 at the time and it triggered a two-week rally back to $52.47. This is a now a news driven market so it can turn on a dime if China repeats the same steps it made in late August. This could cause massive short-covering.

Continue to trade the trend, but have an exit strategy in place before the market opens. I suggest trading a little defensively next week.